What We're Watching - Coronavirus and the Markets

The emergence of the coronavirus strain known as COVID-19 has not only had an impact on the way we conduct our daily lives in a short period of time, it has also dictated movements in financial markets. The U.S. economy is heavily reliant upon consumption of services and consumer spending to drive GDP growth. Both areas have been greatly impacted by coronavirus as 30 million Americans are now unemployed, taking the unemployment rate to around 20%. How we spend money on things such as movies, sporting events and travel will shift as precautions are taken to limit potential exposure to the virus. Economic uncertainty and market volatility have subsided somewhat over the past month, but could return quickly should a ‘second wave’ of COVID-19 flare-up in the Fall/Winter, or the data surrounding the U.S. economy reopening appear to indicate a much more gradual and uneven rebound from the economic stall in place throughout the back-half of March and the entirety of April.

Consumer and investor sentiment are crucial drivers of both the U.S. economy and markets -- and markets dislike the kind of uncertainty that comes with events such as the current one. Questions remain as to the impact of coronavirus on our communities and what it will ultimately mean for consumer spending patterns and corporate confidence/investment. These unknowns make it challenging to model the potential impact on corporate earnings over the coming quarters with any level of confidence and, by extension, what multiple of earnings investors should be willing to pay for stocks given this backdrop.

Treasury yields and equity market volatility are two variables we highlighted as worth monitoring for signs of a potential sustained rebound in stocks materializing, and there has been significant progress on both fronts over the past two months. Yields on long-term U.S. Treasury bonds have moved higher of late, appearing to find support around 0.60%, a positive sign, but one we would like to see confirmed by the 2-year U.S. Treasury yield moving higher as well. The 2-year yield below 0.20% indicates that the Federal Open Market Committee (FOMC) isn’t expected to be able to raise the fed funds rate any time soon and that near-term investor expectations for economic growth and inflation should remain subdued. With the yield curve having steepened, the 2/10 spread will be one bond market indicator to monitor as a flattening of that portion of the curve would indicate a flight to safety via long-dated Treasuries and/or lower expectations for U.S. economic growth.

In late March, daily volatility in stocks reached levels last seen during the most chaotic days of the Global Financial Crisis during 2008 as investor fear was palpable amid the initial stages of an unprecedented U.S. economic shutdown. Nearly two months later, and after the Fed and Treasury announced numerous lending and credit facilities to provide relief to consumers and corporations and the US government announced multiple fiscal stimulus measures, volatility has subsided. The CBOE Volatility Index, or VIX, is now in the high-20’s, still above the historical average of around 20, but closer to more ‘normal’ levels relative to where it was in late March. VIX moving closer to 20 and sustaining such a move would be indicative of less investor demand for hedges as protection against a significant equity market decline.

For more current information from Regions Asset Management about coronavirus and current market events, please visit the following links:

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